Tuesday October 20

Stocks fall marginally as data out of Europe and weak US earnings drive headlines. The S&P500 traded down to 2,030 and the Dow Jones fell 0.1% to 17,217. European data today showed that bank lending was picking up in the region which reduced further easing expectations. The recent risk on in global markets has in part been driven by expectations for more accomodative monetary policy in both the US and the eurozone. At the beginning of September futures markets priced in a 59% chance of tightening by the end of the year, whereas now that figure stands at only 32%. This has been a bullish driver for stocks in recent weeks. Further hopes that the ECB will expand it’s current program have been reduced following todays data and ahead of the ECB meeting on Thursday. However some analysts still expect an expansion to the e60bn/ month quantitative easing program either at the end of 2015 or the beginning of 2016. The euro rises 0.3% against the dollar to $1.1353 and the German bund yields rises 6 basis points to 0.62%. The US ten year yield rose 4 basis points to 2.07%. The Australian dollar rose 0.1% to $0.7258 as the Bank of Australia said that the economy was performing well, which led investors to believe that further tightening will not be necessary. The dollar index finished largely unchanged at 87.24. Weak earnings in the US came from IBM, Harley Davidson, and Chipotle.

Yields on non-investment grade securities are ticking upwards again. Investors want to be compensated for taking on additional risk in the current environment. Yields have risen above 8% which could be an early indicator of similar shifts in other fixed income markets. Similarly high yield companies are struggling to find demand for new issuances. In recent years investors had appetite for these bonds due to the record low interest rate environment, however now investors are looking for exits as yields are expected to rise elsewhere. In some ways the reallocation seems to be taking place further down on the credit rating spectrum within high yield. An index of BB rated high yield bonds is down only 2.3% while on the other hand an index on CCC rated bonds is down 8.9%. High yield issuance is down 9% from the previous year and leveraged loan origination is down 33%. $14.3bn has been withdrawn from high yield mutual funds. Originally only energy and commodity exposed companies were experiencing widening spreads, however now that trend is expanding into other industries such as aerospace & defense, as well as pharmaceuticals. S&P downgrades are high this year.
Volkswagen securitization products are being scrutinized in the aftermath of the emissions scandal. VW typically packages auto loans and lease agreements and sells them to investors as securitized products. Spreads on VW debt have doubled in the wake of their emissions scandal. The ECB had previously been purchasing these products as part of their quantitative easing program, however it has now stopped. The doubt and scrutiny over these securitized products comes from residual value risk. The ABS transactions are dependent on the resale value of the car at the end of the lease in order to repay investors. In this way investors are exposed to increased risks if the cars are worth significantly less than estimated. S&P and Moody’s are currently examining those risks.
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Tuesday October 20

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